Which Student Loan Repayment Plan is the Best Option for You?

Student loan debt has become a struggle for many Americans. The total debt outstanding is nearly $1.5 Trillion, and more than seven million borrowers are in default. Millions more are behind on payments, or unable to make more than the minimum monthly payment.

For those with outstanding student loan debt, there are several options that might ease the repayment burden. These include:

  • Enrolling in a government sponsored repayment plan (this post)
  • Refinancing your student loans with a private lender
  • Consolidating your federal student loans

I encourage you to read each article if you are struggling with your student loan debt.

What is a Student Loan Repayment Plan?

Most students borrow directly from the Federal Government. Private lenders also offer student loans, but the federal loan program dominates in America. There are several different types of federal loans, including:

  • Direct Subsidized Loans
  • Direct Unsubsidized Loans
  • Direct PLUS Loans
  • Direct Consolidation Loans
  • Subsidized Federal Stafford Loans
  • Unsubsidized Federal Stafford Loans
  • FFEL PLUS Loans
  • FFEL Consolidation Loans

Because of this, the Federal Government has created several different student loan repayment programs that borrowers can choose between. These programs vary with regard to payment amount, length of repayment, eligibility requirements, etc.

Note, private loans are not eligible for these repayment programs. Parent PLUS Loans are not eligible for any income-driven repayment plans, other than the old ICR variety which is inferior to all newer options mentioned below.

Traditional Repayment Plans

There are three traditional repayment plans, available to all borrowers.

Standard Repayment Plan

This is the default option for borrowers. It has no special benefits, and offers the following features:

  • If you have a consolidated federal loan, the repayment schedule is between 10-30 years (depending on the total balance)
  • If you have a direct loan, the standard 10-year repayment schedule applies
  • The monthly payment is fixed, at a fixed interest rate
  • There is no possibility for loan forgiveness

This repayment plan is suitable if you have relatively low levels of student debt, or if you plan on paying down the debt rather quickly (because it’s the default enrollment option requiring the least paperwork). If you have substantial student loan debt that will take years to repay, consider looking at the income-based repayment options below.

Extended Repayment Plan

This option is almost identical to the standard plan mentioned above, but the repayment schedule is 25 years (instead of 10 years).

The only benefit to this plan is lower monthly payments, but you will pay much more interest over the life of your loan.

Graduated Repayment Plan

This plan maintains the 10-year repayment schedule, but changes the required monthly payment. Your initial monthly payment is much lower on this plan, but the payment amount increases every 2 years.

The benefit is lower monthly payments in the early years of repayment. The downside is additional interest payments over the life of the loan. Even though the early payments are a reduced dollar amount, the loan still accrues interest at the stated rate, which means you will pay more interest over the life of the loan (when compared to the standard repayment plan).

Summary

Out of these traditional plans, the default standard plan is the best option for most people because it minimizes the amount of interest paid.

Income-Driven Repayment Plans

An income-driven repayment plan sets your monthly student loan payment at an amount that is based on your income and family size. Your required monthly payment amount may increase or decrease if your income or family size changes from year to year. Each year you must “recertify” your income and family size.

There are now five different income-driven repayment plans available:

  • Income-Contingent Repayment (ICR)
  • Pay As You Earn (PAYE)
  • Revised Pay As You Earn (REPAYE)
  • Income-Based Repayment (IBR)
  • Income-Based Repayment for New Borrowers (New IBR)

ICR is the oldest option, and typically not worth considering.

PAYE is the gold-standard today. If you qualify, don’t even consider the other options.

Instead of listing each plan separately, I’m going to discuss the important considerations that apply to each.

Income Eligibility Requirements

Most income-driven repayment options (PAYE and IBR) require that a borrower demonstrate a “Partial Financial Hardship” to establish eligibility. Generally, a borrower meets this requirement if his/her loan balance is greater than annual discretionary income.  Discretionary income is defined as the difference between a borrower’s Adjusted Gross Income (AGI) and 150% of the poverty guideline for the borrower’s family size.

To satisfy the Partial Financial Hardship condition, the monthly payment you would be required to make under the income-driven plan must be less than what you would pay under the Standard Repayment Plan with a 10-year repayment schedule.

REPAYE does not require that borrowers demonstrate a Partial Financial Hardship (PFH).

Loan Date Eligibility Requirements

In addition to financial restrictions, some of these programs are restricted by the date of your loans.

PAYE is limited to people who were new borrowers as of October 1, 2007 and took out a student loan on or after October 1, 2011.

IBR varies by loan date. The original IBR is available to everyone. New IBR is limited to those who began borrowing after July 1, 2014 (no outstanding federal loans before that date).

REPAYE is available to everyone.

Calculating Monthly Payments

Maximum monthly payments are set at 10% or 15% of discretionary income, depending on the plan. Discretionary income is defined as the difference between a borrower’s Adjusted Gross Income (AGI) and 150% of the poverty guideline for the borrower’s family size.

Here is a nice graph created by Studentaid.gov to illustrate this:

The maximum monthly payment amount the borrower is required to repay under IBR and PAYE is capped at the amount the borrower would have paid under the standard 10-year repayment plan.

The maximum monthly IBR payment varies. The New IBR plan is superior to the old (10% of discretionary income for the new IBR vs 15% for the old IBR), but is not available for borrowers with student loans received before July 1, 2014. If you have received your first student loan after that date, you are eligible for the New IBR terms.

There is no cap on monthly payments under REPAYEThe lack of a monthly payment cap is intended to ensure that high-earning borrowers will continue to make payments set at a percentage of income.

Tax Treatment

Most income-driven repayment options (PAYE, REPAYE, and IBR) allow the borrower to choose their tax status. Married individuals can file jointly and have monthly payments based on joint AGI (and combined student loan debt), or file separately and have monthly payments based on individual AGI (and individual student loan debt).

Under REPAYE, married borrowers must pay based on combined household income; no option to file separately is provided.

Loan Forgiveness

Under PAYE and New IBR, if a borrower has not repaid the loan in full after 20 years of qualifying monthly payments, any outstanding balance on the loan will be forgiven.  Under the old IBR, loan forgiveness requires 25 years of payments.

REPAYE provides for loan forgiveness after 20 years, if the loans being repaid were borrowed for undergraduate study.  If the loans were used for graduate or professional study, the borrower will be required to continue making payments for 25 years before forgiveness of any remaining balance.

Under any of these plans, any forgiven loan balance will be treated as taxable income.

All of these plans qualify for Public Service Loan Forgiveness (PSLF). The PSLF program forgives the remaining balance on your Federal Loans after you have made 120 qualifying monthly payments under a qualifying repayment plan (all income-driven repayment plans qualify) while working full-time for a qualifying employer (Government organizations at any level and non-profit organizations).

The most incredible part is that after 120 monthly payments (10 years), your full loan balance is forgiven tax-free. You don’t owe any taxes on the forgiven portion.

PSLF is a no-brainer if you work for a qualifying organization and utilize any of the income-driven repayment plans.

Summary and Conclusions

There is much to consider when choosing a loan repayment plan. For those that desire a quick summary, consider the following:

Standard 10-year Repayment Plan – Suitable for those with low levels of debt, who don’t want to hassle with additional paperwork. This is the default repayment plan.

REPAYE Plan – Available to anyone, and a great option for those looking to make smaller monthly payments for many years. Loans are forgiven after a set number of years (20 or 25). The biggest downside is that your loan payment will always be 10% of your discretionary income, with no cap. If you earn more, you will pay more each month.

PAYE Plan – This is the best income-driven repayment plan, if you qualify (have financial hardship and meet the loan distribution date guidelines). Monthly payments are capped, and any loans are forgiven after 20 years of timely payments.

IBR Plan – This is inferior to PAYE, but easier to qualify. IBR does not require specific loan dates, but does require financial hardship. The biggest difference between IBR and PAYE is that IBR payments are often capped at 15% of your discretionary income (instead of 10%), and loans are forgiven after 25 years of timely payments (instead of 20).

Please feel free to share your own experience or ask any relevant questions below.

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